How Soaring Executive Compensation Can Be A Good Thing

In this issue of IBJ, we present an Ivey Interview with Landsbankinn CEO Steinthór Pálsson, who has spent the last four years repairing the reputation and balance sheet of Iceland’s largest bank. It was a massive challenge and Pálsson accepted a huge pay cut to take it on. That started me thinking about the thorny issue of executive compensation.

As I tried to wrap my mind around why an Icelandic banker responsible for restoring trust in the financial system is worth less than the ones who destroyed it, two seemingly unrelated news items caught my attention. The first involved institutional investor concerns over the compensation paid to Barrick Gold chairman John Thornton (for more on this topic see “Why Canada should adopt a mandatory say-on-pay,” Ivey Business Journal, March/April 2014). The second was about Magna International’s need to assure shareholders that honorary chairman Frank Stronach will soon be cut from the company payroll.

Thornton’s pay has been an issue ever since he received $16.8 million, including an $11.9-million bonus, in 2012, when he signed on to take over as chairman from company founder Peter Munk. Last year, excluding pension costs, Thornton was awarded $8.9 million. “We continue to be concerned with the company’s practice of granting outsized awards on a largely discretionary basis, which we believe is inconsistent with the governance principle of pay-for-performance,” the Canada Pension Plan Investment Board announced this year. In 2010, Stronach cut a controversial deal that kept an annual compensation stream in place for four years after he received an $850-million-plus payment to give up control of Magna. As a result, he was paid over $50 million by the company last year. “The Stronach compensation arrangements will not be renewed, extended or replaced with any other form of compensation,” emphasized Magna’s 2014 annual general meeting circular.

Thanks to his massive pay and fondness for dual-share structures, Stronach has long been a target of the corporate governance crowd. Under his leadership, Magna’s AGMs were a broken record that played two theme songs—”I’m worth every penny” and “My way or the highway.” At the shareholder meeting in 2004—when Stronach was paid $36 million, about $25 million more than the head of GM—he referred to himself as a king while challenging anyone to attack his pay after looking into Magna’s history.

Criticizing Stronach is obviously fair game. But in addition to building Magna into a multi-billion dollar empire, Stronach deserves credit for his early commitment to corporate social responsibility and a rather unique contribution to the debate on executive pay. And it is important to note that Stronach’s compensation was never discretionary (like Thornton’s pay). If truth be told, it was fixed to performance, just not Stronach’s performance.

Born and raised in Austria, Stronach set out for Canada to make his mark at age 21. He was armed with about $200, eight years of experience in the tool and die trade and an endless supply of determination. Working odd jobs, he saved enough to open a machine shop in a Toronto garage in 1957. He worked hard and slept on a cot in the corner. Customers were attracted to his motto: “Better product for a better price.” In 1960, he landed a contract to produce sun-visor brackets for General Motors. In 1969, he merged with a public aerospace, defence and industrial components manufacturer. He focused the combined business, eventually building it into the most diversified automotive supplier on the planet.

Stronach, however, is not your typical capitalist. He has his own “Fair Enterprise” philosophy, which sees no place for so-called “stock flippers” in the corporate boardroom. He’d rather have managers and shareholders predetermine how a company splits profits, while setting a few clear performance requirements and limits on executive power. After that, he thinks publicly traded companies should be free to run like private ones. That is what he did with a corporate constitution.

Stronach gained an iron grip over all things Magna in 1978, when more than 66 per cent of shareholders agreed to hand him management control in return for about 25 per cent of his shares. Six years later, after determining that he had too much power, Stronach created the “Magna Carta” to contractually limit senior executive compensation to below-average salaries and bonuses handed out only if profits were generated for all stakeholders. When Magna was operating in the black, Stronach’s system paid 6 per cent of pre-tax profit to senior management (he got three per cent) while 10 per cent went to employees and two per cent supported “the basic fabric of society.” Predetermined amounts also went to R&D and shareholders, who retained the right to name new directors if Magna failed to generate a return of at least four per cent two years in a row.

As I noted in Canadian Business magazine years ago, Stronach was once considered God’s gift to corporate governance for taking a stand against execs who, in Stronach’s words, “stuff their pockets with all the gold they can find.” In 1984, not everybody agreed with his assessment that the document was “perhaps the most important chapter in western industrial society in many years.” But it was widely seen as a bold initiative. Thirty years later, I can understand why critics think Magna should have stopped paying Stronach when he gave up control. But I will never understand why anyone complained when Stronach’s pay kept rising year after year since it was directly tied to a fixed percentage of pre-tax profit. In other words, when Stronach got more, so did everyone else with skin in the Magna game. And that, I think, is a relatively good template for executive pay, at least if the profits in question are real.